THEORIES OF MERGERS

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EFFICIENCY THEORIES

Differential efficiency theory. Inefficient management theory. Synergy. Pure diversification. Strategic realignment to changing

environment. Undervaluation.

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DIFFERENTIAL EFFICIENCY

According to this theory if the management of firm A is more efficient than the firm B and if the firm A acquires firm B, the efficiency of firm B is likely to be brought up to the level of the firm A.

The theory implies that some firms operate below their potential and as a result have below average efficiency.

Such firms are most vulnerable to acquisition by other more efficient firms in the same industry. This is because firms with greater efficiency would be able to identify firms with good potential but operating at lower efficiency.

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INEFFICIENT MANAGEMENT THEORY

This is similar to the concept of managerial efficiency but it is different in that inefficient management means that the management of one company simply is not performing upto its potential.

Inefficient management theory simply represents that is incompetent in the complete sense.

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SYNERGY

Synergy refers to the type of reactions that occur when two substances or factors combine to produce a greater effect together than that which the sum of the two operating independently could account for.

The ability of a combination of two firms to be more profitable than the two firms individually.

There are two types of synergy: Financial synergy. Operating synergy.

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PURE DIVERSIFICATION

Diversification provides numerous benefits to managers, employees, owners of the firms and to the firm itself. Diversification through mergers is commonly preferred to diversification through internal growth, given that the firm may lack internal resources or capabilities requires.

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STRATEGIC REALIGNMENT TO CHANGING ENVIRONMENT

It suggests that the firms use the strategy of M&As as ways to rapidly adjust to changes in their external environments. When a company has an opportunity of growth available only for a limited period of time slow internal growth may not be sufficient.

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HUBRIS HYPOTHESIS

Hubris hypothesis implies that managers look for acquisition of firms for their own potential motives and that the economic gains are not the only motivation for the acquisitions.

This theory is particularly evident in case of competitive tender offer to acquire a target. The urge to win the game often results in the winners curse refers to the ironic hypothesis that states that the firm which overestimates the value of the target mostly wins the contest.

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